The Importance of Agricultural Finance

While farm work has never been an easy way of life, the last couple of years have proven especially challenging for agricultural businesses. Stubbornly low commodity prices, volatile weather, increased competition, international trade chaos and COVID-19 have all impacted farm-related profits and outlooks. Despite occasional government relief efforts, conditions are likely to remain unstable into the future.

Agricultural finance can help you weigh the impacts of both global and local factors on your operations, from handling debt to managing cash flows. Having a solid handle on the numbers behind your agribusiness can make the complex financial realities more manageable.

Optimizing debt

For most businesses, debt helps smooth cyclical ups and downs, from short-term borrowings to cover this week's payroll to a long-term loan for capital equipment. But when the valleys outnumber the peaks, it's essential to control your borrowing as much as possible to keep your debt load and payments from spinning out of control.

Over the past few years, farm debt levels have increased considerably, as low lending rates and rising farm values eased access to loans. But future expectations may not be as rosy, causing many farmers to reassess debt's role in their financial life. This reassessment generally means closely examining your debt and exploring ways to reduce it.

For a true look at how debt impacts your farm or ranch, run a full inventory of all active loans. This should include how much you borrowed, how much you still owe, who holds the note, how much time is left on the loan, how often you make payments and the interest rate.

Then, create a list of assets such as land, livestock, machinery, equipment, buildings and structures. After that, create an income statement that runs through the business's revenues and expenses, including loan payments. If the costs exceed the income—or sit at an uncomfortably close level—you have two options: reduce expenses or boost revenues.

Because a farm business's income is largely driven by commodity prices that you can't control, the cost side is critical. As you consider the impact of debt-related costs, you may want to consider:

• Reducing your reliance on operating debt, which can evolve into a troubling cycle of loans
• Resetting terms by refinancing higher-rate debt, consolidating smaller loans and stretching the life of the loans to ease short-term demands
• Aligning payment schedules to better match due dates with periods featuring higher cash flows

If you're considering making a large purchase in the coming year, carefully weigh the potential returns to ensure that you'll generate a profit once the loan payments and operational expenses have been covered.

The value of working capital

The role of finance in agriculture encompasses planning for the future as well as day-to-day matters. A key component of your farm's ongoing success is a substantial level of working capital.

Working capital includes cash and assets that you can sell quickly. These are commonly referred to as current assets and are offset by current liabilities, or debts that are due within the next 12 months.

Think of your working capital as a rainy day fund for your business. It should ideally cover between 20% and 50% of your operating expenses. It's best to add to such reserves when times are good, but when challenges arise, that cushion may have to drift lower.

Healthy cash flow is essential to preserve your working capital, especially when adding more capital assets it is out of the question. To shore up your cash flow, consider:

• Focusing on crops, livestock and operations that generate solid revenues and are consistently profitable
• Selling under-used equipment
• Altering your marketing plan to shift cash inflows and outflows
• Delaying larger expenditures
• Reducing your family living budget

Keeping your focus

The long-term success of your farm or ranch does not hinge upon one season or harvest. Focusing on bigger goals commands greater discipline, but the rewards are much more fulfilling than short-lived accomplishments that consume valuable cash and can drive you toward greater levels of debt.

Success evolves gradually over time, through good years and bad. Strong agricultural finance skills can help you fortify the patience and persistence your business needs to grow and thrive.